PARTNERSHIPS 

AND 

S CORPORATIONS

IRS Needs to Improve 

Information to 

Address Tax 

Noncompliance

Report to the Chairman, Committee on 

Finance, U.S. Senate

May 2014

GAO-14-453

United States Government Accountability Office
United States Government Accountability Office

Highlights of GAO-14-453, a report to the 

Chairman, Committee on Finance, U.S. 

Senate

May 2014

PARTNERSHIPS AND S CORPORATIONS

IRS Needs to Improve Information to Address Tax 

Noncompliance

Why GAO Did This Study

Since 1980, partnerships’ and S 

corporations’ share of business 

receipts increased greatly. These 

entities generally do not pay income 

taxes. Instead, income or losses

(hundreds of billions of dollars 

annually) flow through to partners and 

shareholders to include on their 

income tax returns. GAO has 

previously reported that the 

misreporting of income by partners and 

shareholders poses a tax compliance 

risk.

GAO was asked to assess IRS’s 

efforts to ensure compliance by 

partnerships and S corporations. This 

report (1) describes what is known 

about misreporting of flow-through 

income, (2) assesses how much 

misreporting IRS identifies, and (3) 

analyzes possible improvements in 

IRS’s use of data to better identify 

partnerships and S corporations to 

consider examining. Comparing 

partnership, S corporation, and other 

entities’ examination results, GAO 

analyzed 2003-2012 IRS data and 

evaluated possible improvement ideas

stemming, in part, from prior GAO 

work, for how IRS identifies

examination workload.

What GAO Recommends

GAO suggests that Congress consider

requiring more partnerships and 

corporations to e-file their tax returns. 

GAO recommends, among other 

things, that IRS (1) develop a strategy 

to improve its information on the extent 

and nature of partnership misreporting,

and (2) use the information to 

potentially improve how it selects 

partnership returns to examine. IRS

stated it would consider all the 

recommendations and identify 

appropriate actions.

What GAO Found

The full extent of partnership and S corporation income misreporting is unknown. 

The Internal Revenue Service’s (IRS) last study of S corporations, using 2003-

2004 data, estimated that these entities annually misreported about 15 percent 

(an average of $55 billion for 2003 and 2004) of their income. IRS does not have 

a similar study for partnerships. Using IRS data and the study results, GAO

derived a rough-order-of-magnitude estimate of $91 billion per year of 

partnership and S corporation income being misreported by individuals for 2006 

through 2009.

IRS examinations and automated document matching have not been effective at 

finding most of the estimated misreported income. For example, IRS reported 

that examinations identified about $16 billion per year of misreporting in 2011 

and 2012, the bulk of which related to partnerships. However, such information

about compliance results is not reliable. IRS estimated that 3 to 22 percent of the 

misreporting by partnerships was double counted due to some partnership 

income being allocated to other partnerships or related parties. Further, IRS does 

not know how income misreporting by partnerships affects taxes paid by 

partners. IRS does not have a strategy to improve the information. As a result, 

IRS does not have reliable information about its compliance results to fully inform 

decisions about allocating examination resources across different types of 

businesses. 

IRS’s processes for selecting returns to examine could be improved. Not all 

partnership and S corporation line items from paper returns are digitized, and 

IRS officials said that having more return information available electronically 

might improve examination selection. In 2011, about 65 percent of partnerships 

and S corporations electronically filed (e-filed). Certain large partnerships and S 

corporations are required by statute to e-file. Expanding the mandate would 

increase digitized data available for examination selection. Further, in 1995 GAO 

found that IRS’s computer scoring system for selecting partnership returns to 

examine used outdated information. IRS does not have a strategy to update and 

use this information to select partnerships for examination. Relatively few 

partnerships are examined compared to other business entities, and many 

examinations result in no change in taxes owed. Improved examination selection 

based on more current information could generate more revenue and reduce IRS 

examinations of compliant taxpayers.

Fiscal Year 2012 Examination and Adjustment Rates for Different Types of Tax Returns

View GAO-14-453. For more information, 

contact James R. White at (202) 512-9110 or 

whitej@gao.gov.
Page i GAO-14-453 Partnerships and S Corporations

Letter 1

Background 4

Due to Undetected Misreporting, Incomplete Compliance Data, 

and Double Counting of Income within Networks, the Full Extent 

of Partnership and S Corporation Income Misreporting Is 

Unknown 10

IRS Identified a Relatively Small Percentage of Estimated 

Misreported Income through Examinations and K-1 Matching 

and Lacks Reliable Information on Examination Results 15

Options for IRS to Improve Identification of Partnerships and S 

Corporations to Consider Examining Involve Challenges, Some 

of Which Could Be Mitigated 20

Conclusions 27

Matter for Congressional Consideration 28

Recommendations for Executive Action 28

Agency Comments and Our Evaluation 28

Appendix I Objectives, Scope, and Methodology 30

Appendix II Multitiered Networks of Partnerships and S Corporations 36

Appendix III Additional Information about Misreporting 43

Appendix IV Additional Information about K-1 Matching 49

Appendix V Comments from the Internal Revenue Service 52

Appendix VI GAO Contact and Staff Acknowledgments 54

Contents
Page ii GAO-14-453 Partnerships and S Corporations

Tables

Table 1: Flow-through Amounts for Partnership Income and 

Deductions, by Type, Tax Year 2011 17

Table 2: Average Proposed IRS Adjustment to Income for 

Partnership and S Corporation Revenue Agent 

Examinations, Fiscal Year 2012 22

Table 3: Number of Tiers below Partnerships and S Corporations, 

Tax Year 2011 39

Table 4: Types of Ultimate Owners of Partnerships and S 

Corporations, Tax Year 2011 40

Table 5: Individual Taxpayers’ Misreporting of Income, Annual 

Average for Tax Years 2006-2009 46

Figures

Figure 1: The Share of Gross Business Receipts by Partnerships 

and S Corporations Grew from about 7 Percent to about 

34 Percent between Tax Year 1980 and Tax Year 2008 6

Figure 2: Proportion of Aggregate Gross Partnership Business 

Receipts Earned by Partnerships of Different Sizes, Tax 

Year 2008 7

Figure 3: IRS Automated Underreporter (AUR) Process 9

Figure 4: Tiering of Partnerships, Tax Year 2011 12

Figure 5: Fiscal Year 2012 Examination and Adjustment Rates for 

Different Types of Tax Returns 21

Figure 6: A Simple Network and a Multitiered Network 38

Figure 7: Number of Ultimate Owners for Partnerships and S 

Corporations, Tax Year 2011 41

Figure 8: Number of Enterprises and Average Number of Entities 

per Enterprise, by Tiering Depth, Tax Year 2011 42

Figure 9: What Net Misreporting Percentage Means 43

Figure 10: Case Processing Results for Partnership and S 

Corporation Mismatches Involving Schedules K-1 and All 

AUR Mismatches, Tax Year 2009 (Percentages and 

Numbers of Returns) 51
Page iii GAO-14-453 Partnerships and S Corporations

Abbreviations

AIMS Audit Information Management System

AUR Automated Underreporter

DIF discriminant function

EOAD Examination Operational Automation Database

IRS Internal Revenue Service

LB&I Large Business and International

NRP National Research Program

RAS Research, Analysis, and Statistics

SB/SE Small Business/Self-Employed

SOI Statistics of Income

TIGTA Treasury Inspector General for Tax Administration

This is a work of the U.S. government and is not subject to copyright protection in the 

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without further permission from GAO. However, because this work may contain 

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Page 1 GAO-14-453 Partnerships and S Corporations

441 G St. N.W.

Washington, DC 20548

May 14, 2014

The Honorable Ron Wyden

Chairman

Committee on Finance

United States Senate

Dear Chairman Wyden:

Over the past few decades, partnerships and S corporations have 

accounted for an increasing share of business activity in the United 

States.1 For example, from tax year 1980 to tax year 2008, these two 

types of business entities’ share of all business receipts increased from 

about 7 percent to about 34 percent.2

Partnerships and S corporations are flow-through entities, which are 

entities that generally do not pay taxes themselves on income, but 

instead, pass income or losses to their partners and shareholders, who

must include that income or loss on their income tax returns.3 Each year, 

partnerships and S corporations allocate hundreds of billions of dollars of 

income to their partners and shareholders. Individuals, corporations, taxexempt organizations, and other flow-through entities can be partners or 

shareholders and can receive allocations of flow-through income.4

Partnership and S corporation income may be misreported to the Internal 

Revenue Service (IRS) by both the partnerships and S corporations 

 1

An S corporation is a corporation meeting certain requirements that elects to be taxed 

under subchapter S of the Internal Revenue Code. 

2

The year 2008 is the most recent for which IRS compiled complete data comparing gross 

receipts for all business types.

3

Estates and trusts are also flow-through entities. However, in tax year 2011, the most 

recent year for which complete data are available, partnerships and S corporations 

accounted for about 96 percent of net flow-through income (positive income minus losses) 

reported by individuals.

4

Individuals, corporations, trusts, estates, tax-exempt entities, and other partnerships may 

all be partners in a partnership. Individuals, certain trusts, estates, and certain tax-exempt 

entities may be shareholders in an S corporation. See 26 U.S.C. § 1361(b)(1)(B).
Page 2 GAO-14-453 Partnerships and S Corporations

themselves, and the taxpayers to whom they allocate income.5 For 

instance, in 2007, GAO reported that the tax gap—the difference between 

taxes owed and taxes paid on time—for income reported by individuals 

from partnerships, S corporations, estates, and trusts was $22 billion for 

2001. Income from partnerships and S corporations was the primary 

driver for noncompliance for this area.6

One challenge that IRS faces in ensuring that flow-through entities 

comply with tax reporting requirements is that these entities can be linked 

together in multitiered networks. For example, a partnership could be a 

partner in another partnership. In multitiered networks, flow-through 

entities receive allocations from other flow-through entities, and may pass 

the allocations through to still other flow-through entities on their way to 

taxpayers. While there are legitimate reasons for businesses to set up 

networks, such as isolating one part of a business from liability for the 

losses of another part, networks can also be used to evade taxes and 

make misreporting difficult for IRS to identify.

IRS’s efforts to identify tax returns 

to examine for possible misreporting depend on data from both of these 

groups’ returns. Resource limitations and interest in minimizing taxpayer 

burden prevent IRS from examining anything but a small fraction of the 

total number of tax returns—including from partnerships and S 

corporations—filed for a given tax year.

7

You asked us to assess IRS’s efforts to ensure compliance in reporting of 

partnership and S corporation income by individual taxpayers and by the 

entities themselves. The objectives of this report are to (1) describe what 

is known about the extent of income misreporting by partnerships and S 

corporations, and by the individuals to whom these entities allocate that 

income; (2) assess how much misreported partnership and S corporation 

income IRS identifies and assesses taxes on; and (3) analyze how IRS 

 5

The returns that partnerships and S corporations file with IRS are the Form 1065, U.S. 

Return of Partnership Income, and the Form 1120S, U.S. Income Tax Return for an S 

Corporation, respectively. 

6

GAO, Using Data from the Internal Revenue Service’s National Research Program to 

Identify Potential Opportunities to Reduce the Tax Gap, GAO-07-423R (Washington, D.C.: 

Mar. 15, 2007).

7

For more information about tax evasion by networks, see GAO, Tax Gap: IRS Can 

Improve Efforts to Address Tax Evasion by Networks of Businesses and Related Entities,

GAO-10-968 (Washington, D.C.: Sept. 24, 2010).
Page 3 GAO-14-453 Partnerships and S Corporations

could improve its use of data to better identify partnerships and S 

corporations to consider for examination.

For the first two objectives, we collected and analyzed the latest available 

data from various IRS databases, which ranged from 2003 to 2012. Using 

these data, we reviewed IRS estimates of entity-level misreporting, 

estimated individuals’ misreporting of income allocated by partnerships 

and S corporations, analyzed IRS’s examination findings related to that 

income, and reviewed the amount of additional taxes that were assessed 

as a result of IRS’s matching of individuals’ tax returns against Schedule 

K-1 information reporting related to those returns, the only returns against 

which IRS routinely matched K-1s.8

For the third objective, we reviewed various IRS documents and 

interviewed IRS officials to determine how IRS identifies partnership and 

S corporation returns for later classification and examination. In addition, 

we identified different approaches for improving how IRS identifies 

potentially noncompliant returns for eventual examination based on our 

audit findings as well as our past recommendations and 

recommendations made by the Treasury Inspector General for Tax 

Administration (TIGTA), and evaluated the approaches’ costs and 

benefits.

We also analyzed data that IRS 

provided on the extent and nature of tiering of partnerships and S 

corporations.

9

We determined the reliability of the data we used through review of IRS’s 

documentation describing the data, tests of internal consistency, tests for 

We assessed whether the approaches could help IRS identify 

more noncompliance, make examinations more efficient, reduce taxpayer 

burden, or meet other IRS needs. For specific approaches, we evaluated 

whether they might reduce how often IRS examinations resulted in no 

changes to tax returns or how electronic filing (e-filing) rates for 

partnerships and S corporations compared to other e-filing rates.

 8

Partnerships and S corporations use Schedule K-1 to report to partners, shareholders, 

and IRS a partner’s or shareholder’s share of income, losses, credits, and deductions.

9

GAO, Tax Administration: IRS’ Partnership Compliance Activities Could Be Improved, 

GAO/GGD-95-151 (Washington, D.C.: June 16, 1995); TIGTA, Despite Some Favorable 

Partnership Audit Trends, the Number of No-Change Audits Is a Concern, 2012-30-60 

(Washington, D.C.: June 20, 2012); The Recommended Adjustments from S Corporation 

Audits Are Substantial, but the Number of No-Change Audits Is a Concern, 2012-30-62 

(Washington, D.C.: June 21, 2012).
Page 4 GAO-14-453 Partnerships and S Corporations

consistency with published IRS data, and interviews with IRS officials. We 

found the IRS databases we used to be reliable for the purposes of this 

report. All percentage estimates derived from samples used in this report 

have 95-percent confidence intervals that are within plus or minus 10 

percentage points of the estimates themselves, unless otherwise 

specified. All other estimates in this report have 95-percent confidence 

intervals that are within plus or minus 10 percent of the estimates 

themselves, unless otherwise specified. Appendix I contains additional 

details about our scope and methodology.

We conducted this performance audit from January 2013 through May 

2014 in accordance with generally accepted government auditing 

standards. Those standards require that we plan and perform the audit to 

obtain sufficient, appropriate evidence to provide a reasonable basis for 

our findings and conclusions based on our audit objectives. We believe 

that the evidence obtained provides a reasonable basis for our findings 

and conclusions based on our audit objectives.

Partnerships group two or more individuals or entities—such as 

corporations or other partnerships—to carry on a business. Individuals, 

corporations, trusts, estates, tax-exempt entities, and other partnerships 

may all be partners. S corporations may have between 1 and 100 

shareholders. Individuals, certain trusts, estates, and certain tax-exempt 

entities may be S corporation shareholders.10

Partnerships and S corporations differ from C corporations—which are 

covered by subchapter C of the Internal Revenue Code and include 

nearly all publicly traded corporations—in that C corporations pay 

corporate income tax on their profits. Partnerships and S corporations do 

not directly pay taxes on the net income reported on Forms 1065 or 1120-

S. Instead, they pass profits to partners and shareholders, respectively, 

who pay any applicable taxes.

Partnerships and S 

corporations must file tax returns (IRS Forms 1065 and 1120-S, 

respectively).

In recent decades, partnership and S corporation activity has represented 

a growing share of business activity, while the share of C corporation 

 10See 26 U.S.C. § 1361(b)(1)(B). 

Background
Page 5 GAO-14-453 Partnerships and S Corporations

activity has declined, as measured by gross business receipts, the 

revenue that a business receives from its trade or operations before 

subtracting expenses and deductions.11 As a result, a larger share of 

business activity is now subject to taxation at the individual, rather than 

the corporate level, than in the past. According to IRS statistics compiled 

for tax year 1980 through tax year 2008, the percentage of business 

receipts taken in by partnerships and S corporations grew from about 7 

percent to about 34 percent, as shown in figure 1.

 11Gross business receipts do not include portfolio income or income from other flowthrough entities. 
Page 6 GAO-14-453 Partnerships and S Corporations

Figure 1: The Share of Gross Business Receipts by Partnerships and S 

Corporations Grew from about 7 Percent to about 34 Percent between Tax Year 

1980 and Tax Year 2008

a

The percentages for 1980 do not total 100 percent due to rounding.

b

Dollar amounts are adjusted to calendar year 2013 dollars using the chain-weighted gross domestic 

product price index.

c

A sole proprietorship is an unincorporated business that is owned by a single individual.

There were about 4 million S corporations and 3 million partnerships in 

the United States in tax year 2008. However, the bulk of flow-through 

business activity was concentrated in a smaller number of entities. In the 

case of partnerships, 95 percent of business receipts in tax year 2008 

went to the 260,000 partnerships with receipts of $1 million or more (see 

figure 2).
Page 7 GAO-14-453 Partnerships and S Corporations

Figure 2: Proportion of Aggregate Gross Partnership Business Receipts Earned by 

Partnerships of Different Sizes, Tax Year 2008

Note: Numbers may not match up precisely due to rounding.

Partnerships and S corporations are required to send each of their 

partners and shareholders a Schedule K-1 that reports how much income 

or loss they allocated to that partner or shareholder in the past year, and 

to send a copy to IRS.12

IRS has multiple compliance assurance processes. Two important ones 

for detecting misreporting of partnership and S corporation income are 

examinations (commonly known as audits) and K-1 matching.

Individuals and business entities to which 

partnerships and S corporations allocated income are required to report 

that income on their income tax returns.

 1226 U.S.C. §§ 6031, 6037; 26 C.F.R. §§ 1.6031(a)-1, 1.6037-1.
Page 8 GAO-14-453 Partnerships and S Corporations

Examinations are IRS reviews of an entity’s or individual’s books and 

records conducted to verify what is reported on a tax return. They can be 

labor intensive and time consuming for IRS, but can detect complicated 

forms of noncompliance.

IRS may examine a flow-through entity, the partners or shareholders 

(such as individuals) who are allocated income from the flow-through, 

or—if the entity is part of tiered structure of related entities—IRS may 

examine the entire tiered network.

The examination process generally occurs in three steps. Typically, it 

starts with return selection—a largely automated process that selects tax 

returns for further review if they appear to be at risk for noncompliance. In 

the next step—classification—trained staff look at the selected tax returns 

and determine whether they warrant an examination, what issues should 

be examined, and how the examination should be conducted. In the final 

step—examination—a more detailed review of the return and other 

relevant information IRS possesses, such as information returns (for 

example, K-1s), is conducted. The examination generally includes contact 

with the taxpayer and a review of the taxpayer’s books and records. It 

ends with a decision about whether to recommend no change, a refund, 

or additional tax assessment.

K-1 matching is a function of IRS’s Automated Underreporter (AUR) 

program (see figure 3 for a description of the AUR process). AUR 

matches the information returns that IRS receives about a taxpayer with 

income reported on that taxpayer’s Form 1040. Information returns are 

documents, such as W-2s (used to report wages) and K-1s, that third 

parties provide to taxpayers and IRS about taxpayers’ income. K-1 

matching aims to detect mismatches between each taxpayer’s Form 1040 

and K-1s, allowing IRS to detect taxpayers who misreport income from 

partnerships and S corporations. Because taxpayers know that IRS 

receives a copy of each K-1, matching encourages voluntary compliance 

at the taxpayer level.

13

 13In general, income types that are subject to higher levels of information reporting show 

higher levels of taxpayer compliance.

K-1 matching of individual returns is not designed 

to detect misreporting about business operations at the flow-through 

Overview of Examinations 

and Examination 

Workload Identification

Overview of K-1 Matching
Page 9 GAO-14-453 Partnerships and S Corporations

entity level. Additionally, it does not match partnership and S corporation 

returns with the K-1s they receive from other flow-through entities.

Figure 3: IRS Automated Underreporter (AUR) Process

a

Schedules K-1 are information returns that partnerships and S corporations are required to send to 

each of their partners and shareholders, reporting how much income or loss they allocated to that 

partner or shareholder in the past year. They also send a copy to IRS.

b

The reviewer will not issue a notice in cases where the reviewer does any of the following: 

determines that the discrepancy is below a certain dollar amount; transfers the case to another IRS 

unit or division, such as the examination function or Criminal Investigation; or adjusts the taxpayer’s 

account without a notice, which is done when federal withholding or excess Social Security tax is the 

only issue.
Page 10 GAO-14-453 Partnerships and S Corporations

There is substantial uncertainty surrounding the extent of income 

misreporting by partnerships and S corporations themselves, and by the 

individual taxpayers to whom the income is allocated.14

IRS has estimated misreporting by S corporations but not by 

partnerships. In IRS’s most recent study of S corporation misreporting—

covering tax years 2003 and 2004—IRS conducted detailed examinations 

of a sample of S corporation tax returns.15 However, such a study 

inevitably cannot detect all misreporting. IRS analysis of the study did not 

include an adjustment for income that examiners were unable to detect, 

so the true amount of misreporting by S corporations may have been 

significantly larger than IRS reported, according to a preliminary report by 

an official from IRS’s Office of Research, Analysis, and Statistics.16

 14Business entities are also allocated income by partnerships and S corporations. We 

have focused this analysis on individuals. 

For 

15IRS did not publish the results of this study. Selected results from the study were 

presented at the 2009 IRS Research Conference, held on July 8, 2009. 

16IRS generally adjusts its research examination estimates on individual noncompliance to 

account for examiners not having all of the necessary information with respect to 

circumstances surrounding taxpayers’ true reporting obligations, and examiners’ differing 

abilities to detect noncompliance. It does so by quantifying the extent to which 

examination results depend on who conducted the examination, essentially constructing a 

statistical profile of the theoretical best examiner possible. IRS officials told us that 

constructing such a model for the S corporation study was not possible because the study 

did not collect unique identifiers specifying which examiner worked on each return.

Due to Undetected 

Misreporting, 

Incomplete 

Compliance Data, 

and Double Counting 

of Income within 

Networks, the Full 

Extent of Partnership 

and S Corporation 

Income Misreporting 

Is Unknown

Partnerships and S 

Corporations
Page 11 GAO-14-453 Partnerships and S Corporations

those two years, using a weighted average, IRS estimated that S 

corporations misreported about $55 billion per year in net income.17

Because IRS has not conducted a similar study of partnerships since 

1988, and does not have plans to conduct one, it does not have a similar 

estimate for partnerships. Moreover, estimating total partnership income 

or loss and the misreported amounts of income and loss is complicated 

by the fact that substantial portions of those amounts get double counted 

as they pass from one partnership to another.18 IRS data show that in 

2011, partnerships reported a total of $1,468 billion of income and $507 

billion in losses.19 About 31 percent of this income and 36 percent of the 

losses were allocated to other partnerships before ultimately being 

passed on to another party, resulting in double counting of this income 

and losses. Partnerships may also allocate income to others, including S 

corporations, estates, and trusts, which would complicate correcting for 

double counting. About 31 percent of partnerships were part of multitiered 

networks in tax year 2011, as shown in figure 4.20

 17Relative margins of error for all estimates are less than plus or minus 10 percent unless 

otherwise noted. However, due to non-sampling error related to the uncertainty about 

undetected misreporting, actual amounts may be outside of those margins. Approximately 

25 percent of the returns used for the S corporation study were from tax year 2003 and 75 

percent from tax year 2004. All numbers we report based on the study use a 

corresponding weighted average of results from the two years.

See appendix II for 

more information on tiering of flow-through networks.

18Throughout this report, we use the term double counted to refer to items that are 

counted two or more times (not necessarily exactly two times).

19A total of $1,468 billion was reported by partnerships with positive values for total 

income (losses) after subtracting deductions. A total of negative $507 billion was reported 

by partnerships with negative values for total income (losses) after subtracting deductions.

20See appendix I for discussion of the data source and data limitations of our estimates 

about multitiered networks.
Page 12 GAO-14-453 Partnerships and S Corporations

Figure 4: Tiering of Partnerships, Tax Year 2011

Notes:

A simple network is a network that includes a flow-through entity that does not receive allocations 

from another flow-through entity nor allocate income to another flow-through entity. A multitiered 

network includes at least one flow-through entity that allocates income to another flow-through entity.

Because the database containing the data this figure is based on has incomplete data, the extent of 

tiering presented in this figure represents a minimum amount, and counts are approximate.

Numbers do not sum to total, and dividing entity counts by totals do not match up with percentages, 

due to rounding.

Without a strategy for better estimating the extent and nature of 

partnership misreporting, IRS cannot make fully informed decisions on 

how to allocate resources across enforcement programs and across 

different types of business entities and taxpayers. IRS’s strategic plan for 

2009-2013 calls for IRS to develop improved research-driven methods 

and tools to detect and combat noncompliance and improve resource 

allocation. As we discussed in a 2012 report, optimizing resource 

allocation has the potential to bring in substantially more enforcement 

revenue.21

 21GAO, Tax Gap: IRS Could Significantly Increase Revenues by Better Targeting 

Enforcement Resources, GAO-13-151 (Washington, D.C.: Dec. 5, 2012). 
Page 13 GAO-14-453 Partnerships and S Corporations

IRS’s compliance research studies have produced data on flow-through 

income misreporting by individual taxpayers. Using this information, and 

considering various caveats and uncertainties, we estimated a rough 

order of magnitude of the misreporting to be $91 billion per year for tax 

years 2006 through 2009.22

This estimate does not cover all flow-through income. Only some types of 

income—ordinary business income, rental income, and guaranteed 

payments—can be included in an estimate of income that individuals 

misreported from partnerships and S corporations.23 These items are 

reported on a section of the individual tax return specific to income from 

partnerships and S corporations. Some other types of income individuals 

receive via partnerships and S corporations, including interest, dividends, 

and royalties, cannot be estimated based on available data because they 

are combined with the same types of income from nonflow-through 

sources on another part of the individual tax return.24

Additionally, there is uncertainty surrounding any estimate of how much 

income individual taxpayers misreported due to presumed misreporting 

that IRS research examiners are inevitably unable to detect. IRS 

assumes that such misreporting exists and adjusts its estimates to 

account for it when it does its compliance studies on individual taxpayers. 

For individual taxpayers, an estimate of the rate of partnerships’ and S 

corporations’ misreporting of their own income can be incorporated into 

the adjustment, since errors at the entity level would generally be passed 

through to individual taxpayers. The individual misreporting rate would be 

expected to be at least as high as the misreporting rate for the entities 

that are allocating income to them. However, as mentioned above, IRS’s 

most recent estimate of S corporation misreporting is itself uncertain, and 

IRS does not have a similar estimate for partnerships.

 22The relative margin of error for this estimate is under plus or minus 10 percent. 

However, due to non-sampling error related to the uncertainty about undetected 

misreporting, the actual amount may be outside of those margins. 

23Ordinary business income is the income a business earns from its own trade or 

business activities.

24For example, interest passed through from partnerships and S corporations and interest 

from nonflow-through sources are both reported on line 8a of Form 1040.

Individual Taxpayers
Page 14 GAO-14-453 Partnerships and S Corporations

With these caveats in mind, we estimated, based on IRS research 

examination data, that in tax years 2006 through 2009, the annual 

average income that individual taxpayers were allocated from 

partnerships and S corporations was $517 billion, and annual average 

losses were $94 billion, for a net of $423 billion.25 Of this $423 billion, we 

estimated that individual taxpayers misreported about $91 billion per year 

(this amount includes understated income plus overstated losses, less 

overstated income and understated losses). These taxpayers paid their 

taxes based on the misreported amounts, and we estimated that the $91

billion corresponded to about $19 billion per year in lost tax revenue. This 

$91 billion likely includes some of the $55 billion of misreporting by S 

corporations, but IRS is unable to calculate how much.26 Given all of the 

uncertainty involved, these estimates should both be considered rough 

orders of magnitude. See appendix III for details on our estimation 

methodology and more information on factors contributing to uncertainty, 

as well as a comparison of individual taxpayers’ misreporting of income 

from partnerships and S corporations with misreporting of other types of 

income.

 25We estimated that individual taxpayers with positive values for income (losses) from 

partnerships and S corporations had an annual average total of $517 billion of such 

income (with a relative margin of error of plus or minus 10.1 percent), and that individual 

taxpayers with negative values for income (losses) from partnerships and S corporations 

had an annual average total of negative $94 billion of such income (with a relative margin 

of error of 20.2 percent). The net of $423 billion has a relative margin of error of 13.3 

percent. 

26An unknown amount of the income misreported by individuals resulted from individuals 

reporting a different amount of income to IRS than they actually were allocated by 

partnerships and S corporations, while the partnerships and S corporations reported the 

correct amount to IRS. Another unknown amount resulted from the partnerships and S 

corporations reporting their own income incorrectly to IRS, which (as mentioned already) 

should be reflected in misreporting by the ultimate taxpayers.
Page 15 GAO-14-453 Partnerships and S Corporations

IRS examinations have not been effective at finding most of the 

misreported income discussed above. According to information that IRS 

collected for revenue agent examinations closed in fiscal years 2011 and 

2012, IRS proposed increasing the total income reported by partnerships 

and S corporations by an annual average of about $16.3 billion.27

Additionally, for just partnerships, which accounted for the bulk of 

proposed partnership and S corporation adjustments, IRS estimated that 

from 3 percent to 22 percent of the proposed adjustments were double 

counted in the $16.3 billion total. An unknown amount of IRS’s proposed 

adjustments to entity-level income included adjustments flowing through 

multiple tiers of flow-through entities or showing up in related returns, 

resulting in double counting. Thus, the true amount of unique adjustments 

might be smaller than IRS’s records seem to show.

Adjustments at the entity level can generally only result in increased taxes 

to the extent that adjustments and assessments are subsequently made 

at the partner or shareholder level. IRS officials said that because of 

 27We focused on revenue agent examinations of partnerships and S corporations 

because tax compliance officers conduct very few examinations of these entities. In 

general, revenue agents conduct examinations of more complex tax returns including 

partnerships and corporations, while tax compliance officers primarily conduct 

examinations of individual taxpayers.

IRS Identified a 

Relatively Small 

Percentage of 

Estimated 

Misreported Income 

through Examinations 

and K-1 Matching and 

Lacks Reliable 

Information on 

Examination Results

Examinations
Page 16 GAO-14-453 Partnerships and S Corporations

computer systems limitations, they did not have an estimate of the extent 

to which proposed adjustments to income at the entity level increased 

actual taxes collected at the partner or shareholder level. Because IRS 

does not know how much of what it proposes in adjustments for 

partnerships relates to non-duplicate income, nor to what extent those 

adjustments result in increased taxes collected, it cannot know its return 

on investment for partnership examinations. IRS’s examination rate for 

partnerships is much lower than the rate for C corporations and for sole 

proprietorships. Without a strategy for estimating the effectiveness of 

partnership examinations, IRS cannot know whether the differences in 

examination rates across different types of business entities are justified, 

i.e., whether it is optimally allocating its enforcement resources across its 

enforcement programs. As mentioned above, IRS’s strategic plan calls for 

IRS to develop improved research-driven methods and tools to detect and 

combat noncompliance and improve resource allocation, and optimizing 

resource allocation has the potential to bring in substantially more 

enforcement revenue. However, identifying the taxes collected that result 

from proposed adjustments at the partnership level would require IRS to 

upgrade its computer systems, which would require funding.

As the data in table 1 indicate, partnerships differ significantly in terms of 

the types of income that they earn through their own activities or receive 

from other partnerships, estates, or trusts. These differing characteristics 

may indicate that separate enforcement approaches, focusing on different 

compliance issues, are appropriate for each subpopulation. One 

significant distinction among partnerships is whether they generate 

ordinary business income of their own. More than 40 percent of 

partnerships have no ordinary business income or loss, and about 20 

percent of the ordinary business income and losses that partnerships 

report is simply passed on from other partnerships. A large portion of 

partnership income other than ordinary business income is portfolio 

income. Partnerships can receive interest, dividend, or royalty payments 

directly from the original issuers of these payments, or they can receive 

them as pass-through amounts from other partnerships. Rental income 

(primarily from real estate) is another important type of income.
Page 17 GAO-14-453 Partnerships and S Corporations

Table 1: Flow-through Amounts for Partnership Income and Deductions, by Type, Tax Year 2011

Selected aggregate

data from tax year

2011 partnership returns

Percent of partnerships 

reporting this item

Aggregate net 

positive income 

(billions)

Aggregate

net losses or 

deductions

(billions)

Absolute value of 

amounts received

from other nontaxable

entities as a percent

of the total absolute

value for the line item

Ordinary business income (loss)

a

58.4% $528.0 $272.3 20.4%

Portfolio income (interest, 

dividends, and royalties)

31.2 314.5 – Not identifiable

Net rental real estate income 

(loss)

43.1 102.6 94.4 27.9

Other net rental income (loss) 2.0 7.2

(+/-14%)

5.1

(+/-13%)

Not identifiable

Capital gain (loss) 14.4 599.5 157.3 32.7

Other income (loss) 5.2 227.6 46.5 Not identifiable

Guaranteed payments to 

partners

9.5 63.5 – Not applicable

Schedule K deductions 27.7 – 290.9 Not identifiable

Total net positive income 

(loss) allocated to partnersb $1,467.7 $506.9 32.0

Source: GAO analysis of IRS data.

Notes:

Percent errors are used for dollar estimates. Results with relative margins of error greater than plus or 

minus 30 percent are omitted, and relative margins of error greater than plus or minus 10 percent are 

listed in parentheses. All other dollar estimates are within plus or minus 10 percent of the reported 

values. Percentage point errors are used for percentage estimates, and all percentage estimates are 

within plus or minus 10 percentage points of the reported values.

a

For the last row the numerator equals amounts received from other partnerships based on the 

Analysis of Net Income (Loss) section of Schedule K of Form 1065. For the other rows the 

numerators equal amounts received from other partnerships, estates, and trusts.

b

Rows do not sum to total net positive income (loss) allocated to partners because there is netting of 

different types of income for each taxpayer (a taxpayer may have positive business income offset by 

a capital loss) and the deductions are netted from income rather than added as a negative amount to 

the loss column.

IRS examination program monitoring tabulations currently do not track 

examination rates, no-change rates, or enforcement revenue to cost 

ratios for partnership subpopulations, defined in terms of the types of 

income they earn. Consequently, we do not know whether these 

measures differ significantly across the various groups. Without a strategy 

for better estimating the extent and nature of misreporting by different 

subpopulations of partnerships, and the effectiveness of partnership 

examinations in detecting misreporting by different subpopulations of 

partnerships, IRS cannot enhance its case selection processes to focus 
Page 18 GAO-14-453 Partnerships and S Corporations

its enforcement tools on activities that pose the highest risk of 

noncompliance, as is called for in its strategic plan.

For IRS to make informed decisions in expanding its flow-through income 

compliance initiatives, it would have to resolve what it considers to be 

high-priority problems with the accuracy, completeness, and timeliness of 

K-1 data. In July 2013, an IRS data issues team found that these issues 

included K-1s that were at times missing, unable to be matched to 

partnership returns or validated, unavailable for months, subject to 

misreporting by recipients, and only partially allocating partnership 

income. The IRS team believed the problems hurt IRS’s ability to identify 

partner, partnership, and network compliance issues and use risk 

assessment tools to evaluate them.

To resolve these K-1 data issues, IRS staff presented to IRS 

management 15 short- and long-term potential solutions, most of which 

IRS is waiting to address because of funding considerations. The 

solutions included what IRS considered to be critical fixes needed in 2 to 

3 years, but IRS needed more analysis to identify and address 

partnership return data issues. Without approving other solutions, 

management approved costing out three 1-to-2-year fixes, including 

testing K-1 data programming errors and checking that the data were 

correctly processed. Once the costing out was completed, management 

expected to decide whether to fund these three fixes, although it did not 

provide us a date for making that decision. It had approved nothing else.

For individual taxpayers, in examinations closed in fiscal years 2011 and 

2012, IRS proposed adjusting the total income allocated to the individuals 

from partnerships and S corporations by an annual average of about $2.9 

billion.28

 28Fiscal years 2011 and 2012 were the two most recent years of data available at the time 

we did our analysis.

We calculated this amount based on data from IRS’s 

Examination Operational Automation Database on examinations of 

taxpayers’ returns. Only some types of income from partnerships and S 

corporations—such as ordinary business income and rental income—

could be included in this amount. Other types, including interest, 

dividends, and royalties, could not be included because as noted earlier, 

they are combined with the same types of income from nonflow-through 

sources on individual taxpayers’ returns. Based on an estimated tax rate 
Page 19 GAO-14-453 Partnerships and S Corporations

range of 15 percent to 35 percent, the adjustments to income would have 

corresponded to between $450 million and $1 billion in taxes assessed.29

Some of these $2.9 billion in adjustments potentially would have been 

made due to the $16 billion in adjustments at the partnership and S 

corporation level, but as mentioned above, IRS officials told us that they 

could not quantify the extent to which this would have been the case.

As previously noted, IRS matches K-1s to individual tax returns, but IRS 

does not routinely match K-1s or other information returns to partnership 

and S corporation tax returns. Matching K-1s to partnership and S 

corporation tax returns might provide another tool for detecting 

noncompliance by these types of entities. IRS’s strategic plan calls for 

IRS to develop improved research-driven methods and tools to detect and 

combat noncompliance and improve resource allocation, improve 

compliance by leveraging third-party reporting information, and streamline 

processes to increase the timeliness of enforcement. Rather than waiting 

until costing of data fixes is completed for further management 

involvement, management could begin planning now for how to use the 

improved data. Specifically, IRS could develop a plan for testing, or 

otherwise analyzing the data, to, for instance, determine whether 

matching at the entity level of some combination of K-1s and other 

information returns, could assist in verifying compliance. Matching might 

assist directly, by detecting misreported income, or indirectly by helping 

identify returns with examination potential. Without such a plan, when the 

costing of the data fixes is completed IRS will know the costs but perhaps 

not all of the benefits of moving to implement the data fixes.

For individual taxpayers, because of the way IRS tracks tax assessments 

through AUR, only a portion of the net assessments that resulted from K1 matching can be definitively determined.30

 29From 2006 to 2009, taxpayers with effective tax rates of less than 15 percent had an 

aggregate annual net loss on income from partnerships and S corporations, while 

taxpayers with effective tax rates of 15 percent or higher had aggregate net income.

Specifically, when there are 

mismatches for both K-1 income and other types of income, IRS’s AUR 

30Adjustments in AUR cannot be pinpointed precisely for any of the income or expense 

categories tracked. An evaluation of whether it would be worthwhile for IRS to keep these 

data a different way is outside the scope of this work, as it would require an analysis of the 

AUR program as a whole.

K-1 Matching
Page 20 GAO-14-453 Partnerships and S Corporations

data systems do not separate out the K-1 amounts. With this caveat in 

mind, K-1 matching definitively resulted in net tax assessments of $24 

million for tax year 2009, the latest year for which complete data were 

available. The actual amount could be higher, but is probably a relatively 

small portion of the $19 billion of unpaid taxes we estimated individuals 

misreported of partnership and S corporation income. The entire AUR 

program assessed $8 billion for more than 50 different categories of 

income and expenses.

K-1 matching through AUR, as noted above, is not used to detect 

misreporting between entities in a tiered network, nor is it designed to 

detect ordinary business income misreported on a K-1. As a 

consequence, the information on K-1s may match what is on individuals’

1040s, but both documents may understate the true income amount. 

More details about K-1 matching are discussed in appendix IV.

There are various means through which IRS could improve how it selects 

partnership and S corporation tax returns to examine. As we have 

concluded previously, improving examination selection could have two 

positive impacts: increasing enforcement revenue by better focusing 

examinations on noncompliant taxpayers and reducing burden by 

reducing unnecessary audits of compliant taxpayers.31

IRS must decide how to allocate its enforcement resources based on 

limited information. IRS typically examines about 0.4 percent to 0.5 

percent of partnership and S corporation returns per year, compared to 

about 1.4 percent to about 1.6 percent of C corporations, and 1.5 to 1.9 

percent of nonfarm sole proprietorships that did not claim the earned 

income tax credit. Figure 5 shows these rates for fiscal year 2012.

 31GAO, Tax Administration: IRS Could Improve Examinations by Adopting Certain 

Research Program Practices, GAO-13-480 (Washington, D.C.: May 24, 2013).

Options for IRS to 

Improve Identification 

of Partnerships and S 

Corporations to 

Consider Examining 

Involve Challenges, 

Some of Which Could 

Be Mitigated
Page 21 GAO-14-453 Partnerships and S Corporations

Figure 5: Fiscal Year 2012 Examination and Adjustment Rates for Different Types of 

Tax Returns

The results of partnership and S corporation examinations are difficult to 

interpret. On one hand, IRS’s rate for not recommending adjustments to 

income or expense items on partnership and S corporation examinations 

is relatively high. In fiscal years 2010 through 2012, no-change rates 

ranged between 42 percent and 46 percent for partnerships and 34 

percent and 39 percent for S corporations. These rates are computed for 

the business entity. They do not reflect adjustments at the entity level that 

did not result in adjustments to the ultimate partners’ or shareholders’

individual returns.32

 32An IRS official noted that some partnership and S corporation returns may be marked as 

not changed although the examination resulted in changes at the partner or shareholder 

level. 

No-change rates for partnerships and S corporations 
Page 22 GAO-14-453 Partnerships and S Corporations

exceeded those for nonfarm sole proprietorships and C corporations in all 

3 fiscal years from 2010 through 2012.

On the other hand, when IRS revenue agents proposed income 

adjustments after partnership and S corporation examinations, the dollars 

were significant in absolute size, as shown in table 2. As may be 

expected given the size of the entities involved, the average proposed 

income adjustments for IRS’s Large Business and International (LB&I) 

division returns were higher than for its Small Business/Self-Employed 

(SB/SE) division returns. However, as was the case with no-change rates, 

the proposed adjustments at the entity level do not necessarily show 

whether the ultimate partners or shareholders paid any additional tax at 

the individual level.

Table 2: Average Proposed IRS Adjustment to Income for Partnership and S 

Corporation Revenue Agent Examinations, Fiscal Year 2012 

IRS division

Proposed adjustment per tax return

Partnerships S corporations a

Small Business/Self-Employed $126,867 $90,409

Large Business and International $5,292,472 $484,751

Source: GAO analysis of IRS data.

Note: We focused on revenue agent examinations of partnerships and S corporations because tax 

compliance officers conduct very few examinations of these entities. In general, revenue agents 

conduct examinations of more complex tax returns, including partnerships and corporations, while tax 

compliance officers primarily conduct examinations of individual taxpayers.

a

IRS may double count some proposed adjustments to income in partnership examinations due to 

income flowing through multitiered networks and appearing in related returns.

Not all partnership and S corporation line items are digitized. IRS officials 

said that having more return information available electronically might 

improve examination selection. For instance, when IRS subject matter 

experts with examination experience suggested filters for an SB/SE 

research project to use to identify potentially noncompliant preparers of 

partnership and S corporation returns, the lack of transcription prevented 

SB/SE from using all of the filters.33

Enhancing digitization of paper-filed partnership and S corporation returns 

would involve costs to IRS. In 2010, the direct labor costs and related 

 33Filters are flags that detect certain characteristics.

More Tax Return 

Digitization May Improve 

Workload Identification, 

but Digitizing All 

Partnership and S 

Corporation Return Items 

Is Not an Immediate IRS 

Priority
Page 23 GAO-14-453 Partnerships and S Corporations

overhead to transcribe all then-nontranscribed lines on partnership and S 

corporation returns would have exceeded $6 million for SB/SE and LB&I. 

This amount did not include significant direct labor costs for other 

processing functions such as input correction or quality review or costs to 

reprogram submission processing or post-processing systems, according 

to IRS officials. Responding to our recommendation from 2011, IRS 

considered studying the benefits of transcribing items from many forms to 

match against already-calculated costs.34 However, according to an 

official in IRS’s Return Preparer Office in September 2013, it decided 

against the study because of resource needs and budget constraints. By 

not transcribing more partnership and S corporation line items, IRS might 

be forgoing proposed adjustments to income that could result in 

increased tax assessments that might offset the cost of added 

transcription. However, according to an IRS official, more transcription 

might not be IRS’s highest-priority partnership data problem. A higherpriority problem would be the issues described earlier with the accuracy, 

completeness, and timeliness of K-1 data. Within that context, IRS 

considered improving transcription a critical fix needed in 2 to 3 years. By 

that time, about 5 years would have passed since our 2011 

recommendation, which we continue to believe has merit, but resource 

issues could still exist.

Increasing electronic filing (e-filing) of partnership and S corporation tax 

returns would increase the amount of tax return data that arrive at IRS 

already digitized. Increasing the amount of digitized information arriving at 

IRS would reduce IRS processing costs and also reduce the cost of 

transcribing information from the remaining paper returns. One way to 

increase e-filing is for Congress to mandate it.

Currently, partnerships with more than 100 partners are required by law 

to e-file. Corporations, including S corporations, must e-file if they have 

assets of $10 million or more and file at least 250 returns during a 

calendar year.35

 34GAO, E-filing Tax Returns: Penalty Authority and Digitizing More Paper Return Data 

Could Increase Benefits, 

However, under current law, e-filing cannot be required 

GAO-12-33 (Washington, D.C.: Oct. 5, 2011).

3526 U.S.C. § 6011(e)(2) and 26 C.F.R. § 301.6011-5. In addition, current law generally 

prohibits requiring e-filing by individuals, estates, and trusts, unless the return is prepared 

and filed by a tax return preparer who reasonably expects to prepare more than 10 

individual tax returns during the calendar year. 26 U.S.C. § 6011(e)(1) and (e)(3).

Increasing Electronic 

Filing Would Increase 

Digitization, and the Added 

Burden on Taxpayers 

Could Be Mitigated
Page 24 GAO-14-453 Partnerships and S Corporations

for partnerships with 100 partners or less or corporations, including S 

corporations, unless the entity is required to file at least 250 returns 

during a calendar year.36

The percentages of partnerships and S corporations that e-file tax returns 

have been growing rapidly in recent years, reaching 64 percent and 66 

percent, respectively, in tax year 2011, the latest year for which data are 

available. IRS has projected rapid continued growth for the next couple of 

years and a leveling off after that, meaning that some paper-filed returns 

will always be expected.37

Unless all returns are digitized, IRS will not be able to use all return line 

items in its examination selection process. Less than full digitization limits 

IRS in selecting the most productive returns to examine and increases the 

likelihood of it examining compliant taxpayers. As noted above, 

transcribing the remaining paper returns is not a priority. Without a lowcost way to digitize paper returns, digitizing them is at risk of remaining an 

unfunded critical fix.

However, as noted before, IRS will not be able 

to transcribe more partnership and S corporation line items off the 

remaining paper-filed returns, at least in the short term.

There are various forms a partnership and S corporate e-file mandate 

could take, including:

• requiring paid tax return preparers to e-file partnership and corporate 

returns they prepare;

• requiring e-filing based on a different number of partners in a 

partnership than is the case now;

• requiring e-filing based on whether a partnership already has a 

special responsibility and requirement to file a balance sheet anyway 

and, therefore, may more easily adapt to a new requirement than 

others can; and

 3626 U.S.C. § 6011(e)(2)(B). When requiring e-filing, the ability of taxpayers to comply at 

reasonable cost must be considered, among other relevant factors.

37For instance, IRS projected that 80 percent of partnerships would e-file in fiscal year 

2015 and 86 percent in fiscal year 2020. According to IRS officials, the projections were 

based on processing activity. Processing activity refers to everything related to a particular 

return that goes through IRS in a given processing year. For instance, if two, three, or four 

iterations of a tax return go through IRS, the return is counted two, three, or four times. 

Actual e-filing percentages mentioned here count each return only once.
Page 25 GAO-14-453 Partnerships and S Corporations

• requiring e-filing based on the size of a partnership’s or corporation’s 

assets, with different asset requirements than now exist.38

Any option for an e-filing mandate would impose some burden on tax 

return filers. However, the extent of the burden may be small, since about 

90 percent of partnerships and S corporations already use a paid 

preparer. Additionally, any burden could be mitigated. Waivers allowing 

paper filing in hardship and other special cases could eliminate burden for 

some tax return filers, and thresholds limiting the requirement to entities 

of a certain size (based on number of partners or some other measure) 

would eliminate the burden for entities below that size. Also, phase-in 

periods could allow time for entities to adjust. When IRS implemented the 

preparer e-file mandate for individuals, it found that the number of 

hardship waivers was fewer than anticipated, about 2,250 versus the 

6,000 that had been expected.

SB/SE’s partnership discriminant function (DIF) model to identify entities 

to examine was built on data that are now outdated, and does not capture 

partnership compliance issues related to tiering.39 We pointed out in 1995 

that because the formulas the model relied on were developed using data 

from the 1980s and tax laws and taxpayer behaviors had changed, the 

model unreliably indicated partnership compliance.40

Despite the model’s formulas being outdated, indications are mixed on 

whether the partnership DIF model needs upgrading or is adequately 

identifying a productive workload of potentially noncompliant returns 

compared to other workload identification methods. In two 2012 reports, 

TIGTA found that no-change rates for partnership and S corporation 

At the time, IRS said 

that it was planning to develop new formulas in 1998. However, SB/SE is 

still using the same DIF formulas.

 38As an example of the difference that a mandate on the basis of a balance sheet could 

make, requiring e-filing by partnerships required to file a balance sheet—generally those 

with $500,000 or more in assets and $250,000 or more in receipts—would have covered 

about 75 percent of partnerships in tax year 2011. The 64 percent of partnerships that 

actually e-filed in tax year 2011 presumably included some partnerships with lower levels 

of assets or receipts.

39The DIF model is a mathematical technique used to score income tax returns for 

examination potential.

40GAO/GGD-95-151.

IRS’s Computer Scoring 

System for Identifying 

Partnership Returns to 

Examine Uses Outdated 

Formulas, but Upgrading 

Faces Challenges
Page 26 GAO-14-453 Partnerships and S Corporations

returns selected by the DIF model and examined by nontrainee SB/SE 

revenue agents greatly exceeded those for other SB/SE partnership and 

S corporation returns examined by nontrainees.41

According to IRS officials, updating the partnership DIF model could be 

complicated, expensive, and time consuming, taking resources from 

possibly productive examinations and having an unknown outcome. 

However, without determining whether an improved partnership DIF 

model should be developed after IRS has better information on 

noncompliance and program effectiveness, IRS cannot know whether it is 

missing an opportunity to select partnership returns for examination more 

effectively. IRS’s strategic plan calls for IRS to develop improved 

research-driven methods and tools to improve resource allocation and to 

enhance its case-selection processes in order to focus its enforcement 

tools on activities that pose the highest risk of noncompliance. IRS 

officials told us they have started to look into ways to develop a new 

partnership DIF model, but there is no strategy, time frame, or plan for 

completing this effort.

On the other hand, 

when training examinations are included, LB&I, which did not use the DIF 

model, often had a higher no-change rate for revenue agent examinations 

for partnerships and S corporations than SB/SE, which used the DIF 

model. LB&I pointed out that its blend of returns to be examined may 

differ from SB/SE’s, skewing the comparison.

In 1995 we identified filters, that is, flags that detect certain characteristics 

of partnerships whose examinations were the most productive for IRS to 

examine. In 2012, TIGTA did the same thing for both partnerships and S 

corporations.42

 41TIGTA, 2012-30-60, 2012-30-62.

For instance, for returns selected by the DIF model and for 

returns related to them, TIGTA found the examinations of real estate or 

construction partnerships with two partners and a reported loss were 

highly productive in terms of the size of recommended adjustments. 

Similar to what we had suggested more than a decade earlier, TIGTA 

recommended that, as resources become available, SB/SE analyze 

partnership and S corporation data files looking for ways to better identify 

productive returns for audit.

42GAO/GGD-95-151; TIGTA, 2012-30-60; 2012-30-062.

IRS Is Beginning to Follow 

Up Its Work on Filters to 

Be Used in Examination
Page 27 GAO-14-453 Partnerships and S Corporations

In response, in 2013, SB/SE researchers expanded an earlier study of 

partnership and S corporation returns to test the efficacy for examination 

selection of some new automated filters. They tested the filters on 

completed examinations to determine if using the filters could have 

resulted in a lower no-change rate. Three of the filters that were tested 

showed some promise in terms of reduced no-change rates. The 

researchers recommended that the SB/SE examination function use the 

promising filters to screen returns that the DIF model selected for 

examination and validate that the filters reduce the no-change rate below 

historical averages and are operationally feasible. According to SB/SE 

officials, they have begun that process.

Partnerships and S corporations account for billions of dollars of unpaid 

taxes and their share of business activity is growing. This underscores the 

importance of understanding the effectiveness of IRS’s partnership and S 

corporation tax law enforcement efforts.

Currently, IRS examines a small fraction of partnership and S corporation 

tax returns. Other forms of businesses, such as C corporations and sole 

proprietorships, are examined at rates that are several times higher. IRS 

cannot make fully informed decisions about whether this allocation of 

enforcement resources is justified because it has limited information 

about the extent and nature of income misreporting by partnerships and S 

corporations as well as about the effectiveness of its examinations at 

detecting such misreporting. This also leaves IRS unable to make a fully 

informed, data-based decision about whether or not to update one of its 

major partnership examination selection tools, the DIF formula.

We identified two additional opportunities to better use data to improve 

compliance by flow-through entities. First, enabling greater digitization of 

tax return information would help IRS identify which partnership and S 

corporation tax returns would be most productive to examine. In the 

absence of funding for transcription, one way to increase digitization is a 

statutory mandate requiring increased e-filing of partnership and S 

corporation tax returns. Improving IRS’s selection of partnership and S 

corporation returns to examine would also benefit compliant taxpayers 

whose returns may otherwise be selected for examination. Further, 

expanded e-filing would reduce IRS’s tax return processing costs.

Second, IRS may be able to take advantage of its ongoing efforts to 

improve the quality of K-1 data to test whether compliance processes 

could be improved. Issues with the accuracy and timely availability of K-1 

Conclusions
Page 28 GAO-14-453 Partnerships and S Corporations

data have been a concern to IRS. Planning now for how to use the 

improved data would leave IRS well positioned to analyze options for 

improving its partnership and S corporation compliance programs.

Congress should consider expanding the mandate for partnerships and 

corporations to electronically file their tax returns to cover a greater share 

of filed returns.

We recommend that the Commissioner of Internal Revenue take the 

following steps:

• Develop and implement a strategy to better estimate

(1) the extent and nature of partnership misreporting, and

(2) the effectiveness of partnership examinations in detecting this 

misreporting.

• Use the better information on noncompliance and program 

effectiveness to determine

(1) whether the differences in examination rates across different types 

of business entities are justified, and

(2) whether an improved tool for selecting partnerships for 

examination, such as an updated partnership DIF, should be 

developed.

• While IRS works to improve the quality of its Schedule K-1 data, 

develop a plan for conducting testing or other analysis to determine 

whether the improved Schedule K-1 data, perhaps combined with 

other IRS information about businesses and taxpayers, could be used 

more effectively to ensure compliance with the reporting of flowthrough income.

We sent a draft of this report to the Commissioner of Internal Revenue for 

comment. We received written comments from IRS’s Deputy 

Commissioner for Services and Enforcement on May 6, 2014 (for the full 

text of the comments, see appendix V). We also received technical 

comments from IRS, which we incorporated into the final report where 

appropriate.

Matter for 

Congressional 

Consideration

Recommendations for 

Executive Action

Agency Comments 

and Our Evaluation
Page 29 GAO-14-453 Partnerships and S Corporations

In its written comments, IRS said that it had not yet fully evaluated GAO’s 

recommendations but expressed concerns regarding actions requiring a 

significant expenditure of resources. However, it said it would consider all 

of GAO’s recommendations and identify appropriate IRS actions while 

keeping resource limitations in mind. It is these very resource 

limitations—which we recognize in this report—that underscore the 

importance of our recommendations to develop better information for 

making decisions on how to allocate existing resources.

As agreed with your office, unless you publicly announce its contents 

earlier, we plan no further distribution of this report until 30 days from its 

issue date. At that time, we will send copies to the Secretary of the 

Treasury, the Commissioner of Internal Revenue, and other interested 

parties. The report will also be available at no charge on GAO’s website 

at http://www.gao.gov.

If you or your staff have any questions about this report, please contact 

me at (202) 512-9110 or at whitej@gao.gov. Contact points for our 

Offices of Congressional Relations and Public Affairs are on the last page 

of this report. Key contributors to this report are listed in appendix VI.

Sincerely yours,

James R. White

Director, Tax Issues

Strategic Issues Team
Appendix I: Objectives, Scope, and 

Methodology

Page 30 GAO-14-453 Partnerships and S Corporations

The objectives of this report are to (1) describe what is known about the 

extent of income misreporting by partnerships and S corporations, and by 

the individuals to whom these entities allocate that income; (2) assess 

how much misreported partnership and S corporation income IRS 

identifies and assesses taxes on; and (3) analyze how IRS could improve 

its use of data to better identify partnerships and S corporations to 

consider for examination.

To describe what is known about the extent of income misreporting by 

partnerships and S corporations, we reviewed what IRS’s National 

Research Program (NRP) had done at the entity level. For NRP, IRS 

selects a random sample of tax returns to examine and strives to verify 

information taxpayers and others reported or should have reported. We 

reviewed NRP documents and information on the 2003-04 entity-level 

study of S corporations, which was IRS’s most recent study of S 

corporations. We also interviewed NRP officials about that study and 

what information was available about partnerships.

To describe what is known about the extent of income misreporting by 

individuals with income from partnerships and S corporations, we 

obtained data from NRP for tax years 2006 through 2009, the most recent 

years for which data were available. At the individual level, IRS conducts 

NRP studies annually. IRS uses the NRP data to estimate the tax gap 

and update return selection formulas used in planning examinations. 

Using these data, we estimated the amount of individual taxpayers’

misreporting of income and losses from partnerships and S corporations 

on their Forms 1040, U.S. Individual Income Tax Return. We adjusted our 

raw result based on an IRS estimate of net misreporting percentage. See 

appendix III for a discussion of our and IRS’s estimation techniques. For 

this analysis, we looked only at partnership and S corporation income that 

was separately reported on Schedule E (Form 1040), Supplemental 

Income and Loss. Some income from partnerships and S corporations 

may also be included within, and reported under, other line items on Form 

1040, such as capital gains.

To calculate the amount of taxes that corresponded to our misreporting 

estimate, we used NRP data to calculate the income and misreporting 

that related to individuals with different effective tax rates (defined as total 

tax divided by adjusted gross income). Looking at taxpayers with effective 

tax rates between 15 percent and 35 percent, we calculated lower and 

Appendix I: Objectives, Scope, and 

Methodology
Appendix I: Objectives, Scope, and 

Methodology

Page 31 GAO-14-453 Partnerships and S Corporations

upper bounds for the amount of tax that would have been owed on their 

misreported income from partnerships and S corporations.1

To assess how much misreported partnership and S corporation income 

IRS identifies and assesses taxes on, we obtained data from IRS’s Audit 

Information Management System (AIMS), Examination Operational 

Automation Database (EOAD), and Automated Underreporter (AUR) 

program on K-1 matching. From AIMS, we obtained data on IRS 

proposed adjustments to partnership and S corporation tax returns for 

fiscal years 2011 and 2012, the latest years for which information was 

available when we obtained it.

From EOAD, we obtained data on IRS proposed adjustments to individual 

tax returns for fiscal years 2011 and 2012, the most recent years for 

which complete data were available. With these data, we calculated 

proposed adjustments to income and losses from partnerships and S 

corporations, to income and losses from estates and trusts, and to shortand long-term gains and losses from partnerships, S corporations, 

estates, and trusts. Based on the proposed adjustments and estimated 

tax brackets, we estimated the amount of taxes assessed based on these 

examinations.

Using AUR data for tax year 2009, the most recent year for which 

complete data were available, we reviewed the minimum amount of taxes 

assessed through matching K-1s against individual tax returns, the only 

returns against which IRS routinely matched K-1s. The minimum amount 

was based on returns for which K-1 discrepancies were the only matching 

discrepancies. We also determined the total amount of assessments that 

were not attributed to specific types of income, an unknown portion of 

which might be due to K-1 matching.

We interviewed officials from IRS’s examination and AUR programs to 

determine the reliability of the data and to discuss examination and AUR 

operations. For contextual purposes, we analyzed IRS Statistics of 

Income (SOI) partnership data for 2011. Specifically, we determined 

income, losses, and percentages of income received from other 

 1

From 2006 to 2009, taxpayers with effective tax rates of less than 15 percent had an 

aggregate annual net loss on income from partnerships and S corporations, while 

taxpayers with effective tax rates of 15 percent or higher had aggregate net income; the 

highest tax bracket was 35 percent.
Appendix I: Objectives, Scope, and 

Methodology

Page 32 GAO-14-453 Partnerships and S Corporations

partnerships, estates, or trusts for partnerships earning different kinds of 

income.

To analyze how IRS could improve its use of data to better identify 

partnerships and S corporations to consider for examination, we analyzed 

examination statistics derived from AIMS. For example, to see whether 

IRS’s identification of potential examinations differed across different 

kinds of entities, we compared the percentage of partnership and S 

corporation returns that IRS examined to the percentage of C corporation 

and sole proprietorship returns that it examined. We also compared the 

rate at which IRS examinations recommended no adjustments to items 

reported on partnership and S corporation returns to no-change rates for 

examinations of C corporations and sole proprietorships.

We reviewed IRS guidance and interviewed IRS officials to learn how IRS 

identifies partnership and S corporation returns for later classification and 

examination and to understand to what extent the process is automated. 

From various documents, including GAO and Treasury Inspector General 

for Tax Administration (TIGTA) reports and recommendations, and 

interviews with IRS and Treasury officials, we evaluated the costs and 

benefits of various approaches we encountered that could improve IRS’s 

use of data to better identify partnerships and S corporations to consider 

for examination and reduce the no-change rate for partnership and S 

corporation examinations.2

• Increasing K-1 and partnership and S corporation return 

transcription and other digitization. While considering this 

approach, we determined—from IRS transcription guidance and from 

interviews with IRS officials—how much of the data filed on paper K1s and partnership and S corporation returns are not digitized into IRS 

databases. We also determined any resulting ramifications for 

We assessed whether the approaches 

included steps that IRS was taking or possibly could take to identify more 

noncompliance, make examinations more efficient, reduce taxpayer 

burden, or meet other IRS needs. More specifically, the approaches 

covered the following:

 2

GAO, Tax Administration: IRS’ Partnership Compliance Activities Could Be Improved, 

GAO/GGD-95-151 (Washington, D.C.: June 16, 1995); TIGTA, Despite Some Favorable 

Partnership Audit Trends, the Number of No-Change Audits Is a Concern, 2012-30-060 

(Washington, D.C.: June 20, 2012); The Recommended Adjustments From S Corporation 

Audits Are Substantial, but the Number of No-Change Audits Is a Concern, 2012-30-062 

(Washington, D.C.: June 21, 2012).
Appendix I: Objectives, Scope, and 

Methodology

Page 33 GAO-14-453 Partnerships and S Corporations

workload identification. From IRS documentation and officials, we 

determined the details of how IRS plans to fix problems with the 

timeliness, completeness, and accuracy of K-1s to better use the 

information for workload identification.

• Increasing partnership and S corporation return electronic filing.

We reviewed documents and interviewed IRS and Department of the 

Treasury officials about e-filing. More specifically, we explored the 

status of 2003 TIGTA ideas and subsequent legislative proposals on 

mandating more e-filing of partnership returns. As part of this effort, 

we reviewed past and projected e-filing rates prepared by IRS’s Office 

of Research, Analysis, and Statistics (RAS), including SOI, and 

determined how many partnerships and S corporations would be 

affected by various enhancements to the e-filing mandate. We also 

compared e-filing rates for partnerships and S corporations to other efiling rates.

• Upgrading the computer scoring system for identifying 

partnership returns to eventually examine. From various IRS and 

other documents and officials, we reviewed the history of IRS’s 

computer scoring system, known as the discriminant function, or DIF, 

and the challenges to changing the system. We also reviewed TIGTA 

reports relating to the system.

• Analyzing partnership and S corporation data files to identify 

workload. In accordance with 2012 TIGTA and 1995 GAO ideas on 

using IRS databases, we obtained documentation regarding IRS 

efforts to use partnership and S corporation databases to develop 

examination leads and to select returns to examine.

In addition to our main objectives, we also provided the following 

information in the appendixes. For appendix II, to describe the extent and 

nature of multitiered networks of partnerships and S corporations, we 

obtained data from RAS on the tiering characteristics of partnerships and 

S corporations. The data related to a particular entity include information 

for all owners of at least 0.1 percent of that entity. Using data for tax year 

2011, the most recent year for which complete and reliable data were 

available in the K-1 database that RAS used, we developed charts 

describing the relevant information. We interviewed RAS officials to 

determine the reliability of the data.
Appendix I: Objectives, Scope, and 

Methodology

Page 34 GAO-14-453 Partnerships and S Corporations

For appendix III, to compare individual taxpayers’ misreporting of income 

from partnerships and S corporations with other income types, we 

calculated:

• net misreporting amounts;

• the percentage of taxpayers who misreported;

• the median amount of misreporting; and

• the net misreporting percentage for the following categories of 

income: (1) income from partnerships and S corporations, (2) other 

business income subcategories reported on Schedule E of Form 

1040, and business income categories on Form 1040 itself, with 

estimated reported incomes with absolute values greater than $10 

billion, and (3) the six nonbusiness income categories with estimated 

reported incomes of more than $150 billion reported on Form 1040.

We determined confidence intervals for all our estimates. Although we 

adjusted our estimate of misreporting of income from partnerships and S 

corporations based on an IRS estimate of net misreporting percentage, 

as mentioned above, we presented both the adjusted and unadjusted 

estimates in appendix III since we did not make comparable adjustments 

for the other income categories. We also compared the results for each 

income category with reported IRS determinations of whether the 

category was subject to little or no third-party information reporting, some 

information reporting, or substantial information reporting that IRS could 

match against Form 1040 reporting. We interviewed officials from RAS to 

determine the reliability of the NRP data and to discuss the adjustments 

that IRS makes to the data to calculate its reported net misreporting 

percentage and tax gap estimates.

For appendix IV, we calculated and compared the no-change rates in the 

AUR workload for K-1 matching and for all matching. We also attended 

and asked questions at a joint Information Reporting Program Advisory 

Committee and Internal Revenue Service Advisory Council meeting to 

obtain views on K-1 matching from paid tax return preparers and other 

relevant stakeholders.

We tested the reliability of NRP, AUR, EOAD, AIMS, and SOI data for 

previous GAO engagements, and we supplemented our knowledge 

through interviews with IRS officials and through documentation review, 

and, where applicable, electronic checks. We also tested these data for 

internal consistency, and for consistency with other IRS data when 

available. For example, for AIMS data we analyzed, we tested numbers 

against information published in TIGTA reports and IRS’s Data Book, 
Appendix I: Objectives, Scope, and 

Methodology

Page 35 GAO-14-453 Partnerships and S Corporations

which annually provides information on returns filed, taxes collected, 

enforcement, taxpayer assistance, the IRS budget and workforce, and 

other selected activities. We also checked that the data extracts we used 

from different parts of RAS, including SOI, were consistent with each 

other and with information from the IRS Oversight Board. All percentage 

estimates derived from samples used in this report have 95-percent 

confidence intervals that are within plus or minus 10 percentage points of 

the estimates themselves, unless otherwise specified. All other estimates 

in this report have 95-percent confidence intervals that are within plus or 

minus 10 percent of the estimates themselves, unless otherwise 

specified.

We tested the K-1 data that IRS provided for internal consistency and 

consistency with published IRS data, verified the programming IRS used 

to create tables summarizing the K-1 data, and interviewed the IRS 

official who created the tables. Based on IRS documents and interviews 

with IRS officials, data in the K-1 database may be incomplete. Some K1s may be missing from the database because of problems such as 

partnerships and S corporations failing to file K-1s, IRS errors, and timing 

problems. However, given IRS’s estimates of the level of incompleteness, 

we believe that any inaccuracies would not change percentage results 

enough to change the overall conclusions presented in this report. In 

general, the amounts of tiering shown represent minimums and entity 

counts are approximate because the missing data would add more 

entities and linkages to the tables and charts we present.

We found the IRS databases we used to be reliable for the purposes of 

this report.

We conducted this performance audit from January 2013 through May 

2014 in accordance with generally accepted government auditing 

standards. Those standards require that we plan and perform the audit to 

obtain sufficient, appropriate evidence to provide a reasonable basis for 

our findings and conclusions based on our audit objectives. We believe 

that the evidence obtained provides a reasonable basis for our findings 

and conclusions based on our audit objectives.
Appendix II: Multitiered Networks of 

Partnerships and S Corporations

Page 36 GAO-14-453 Partnerships and S Corporations

Many flow-through entities are connected to each other in tiered 

networks. As we have reported before, networks of related entities are a 

feature of modern business organizations.1

 1

GAO, Tax Gap: IRS Can Improve Efforts to Address Tax Evasion by Networks of 

Businesses and Related Entities, 

Many legitimate reasons 

explain why business owners may choose to use a network of related 

entities to conduct operations. For example, networks can be used to 

isolate one line of business from the potential liabilities or risk of business 

loss of another, to manage a business’s financing arrangements, or to 

separate ventures based in different states and countries. However, 

networks can also be used in complex tax evasion schemes that are 

difficult for IRS to identify. More complex networks also make businesses 

more difficult for IRS to examine. IRS officials said that some businesses 

may believe that if their networks are sufficiently complex, they will be 

difficult for IRS to examine. Therefore, it is helpful to understand the 

extent to which partnerships and S corporations are involved in 

multitiered networks, as well as the complexity of such networks. See the 

text box for tiering terminology.

GAO-10-968 (Washington, D.C.: Sept. 24, 2010).

Appendix II: Multitiered Networks of 

Partnerships and S Corporations
Appendix II: Multitiered Networks of 

Partnerships and S Corporations

Page 37 GAO-14-453 Partnerships and S Corporations

Source: GAO analysis of IRS documents.

Many of the above concepts are illustrated in figure 6, which shows an 

example of a simple network and a multitiered network with a top, middle, 

and bottom tier.

Tiering Terminology

Flow-through Entity: An entity for which income is allocated by the 

business to its owners, with taxes on that income paid only by the 

owners. Taxes generally are not paid by the flow-through entities 

themselves. Flow-through entities include partnerships, S 

corporations, trusts, and estates.

Ultimate Owner: A final recipient of flow-through income allocations. 

Ultimate owners include nonflow-through businesses (e.g., tax-exempt 

entities and C corporations) and individuals.

Simple Network: A network that includes a flow-through entity that 

does not receive allocations from another flow-through entity or 

allocate income to another flow-through entity. It allocates income to 

ultimate owners.

Multitiered Network: A network that includes at least one flowthrough entity that allocates income to another flow-through entity. 

Enterprise: A network of flow-through entities and their owners 

whose economic activity is under the control (defined as 50 percent or 

more direct or indirect ownership) of a single taxpayer or married 

couple.

Top-tier Entity: A flow-through entity that allocates income to another 

flow-through entity (and possibly also to ultimate owners) but does not 

receive allocations from another flow-through entity.

Middle-tier Entity: A flow-through entity that both receives allocations 

from another flow-through entity and allocates income to another flowthrough entity (and possibly also to ultimate owners).

Bottom-tier Entity: A flow-through entity that receives allocations 

from another flow-through entity, but does not allocate income to 

another flow-through entity. It allocates income to ultimate owners.
Appendix II: Multitiered Networks of 

Partnerships and S Corporations

Page 38 GAO-14-453 Partnerships and S Corporations

Figure 6: A Simple Network and a Multitiered Network

In tax year 2011, only about 1 percent of S corporations had 2 or more 

tiers below them (see table 3). More partnerships, on the other hand, had 

greater tiering depths. About 23 percent of partnerships had 2 or more 

tiers below them, and some partnerships had 11 or more tiers below 

them.2 See figure 6 above for examples of how tiers below flow-through 

entities are counted.

 2

This discussion centers on the number of tiers below a given entity, not the number of 

tiers that might be above it, because the focus is each partnership’s and S corporation’s 

investment structure. This means that these numbers do not indicate whether a 

partnership or S corporation is itself part of the investment structure of another flowthrough entity, and therefore do not necessarily indicate whether it is part of a multitiered 

network. Because of this, these numbers do not match the numbers shown previously in 

figure 4. 

S Corporations Have 

Shallow Tiering Depths, 

while Some Partnerships 

Have Greater Depths
Appendix II: Multitiered Networks of 

Partnerships and S Corporations

Page 39 GAO-14-453 Partnerships and S Corporations

Table 3: Number of Tiers below Partnerships and S Corporations, Tax Year 2011

Tiers below entity Partnerships S corporations

Approximate number of entities

1 (ultimate owners only) 2,604,000 4,201,000 

2-10 778,000 35,000 

11+ Less than 1,000 Less than 1%

Total 3,382,000 4,237,000 

Percentage of entities

1 (ultimate owners only) 77% 99%

2-10 23% 1%

11+ Less than 1% Less than 1%

Total 100% 100%

Source: GAO analysis of IRS data.

Notes:

Because the K-1 database does not have complete K-1 data, the extent of tiering presented in this 

figure represents a minimum amount, and counts are approximate.

Columns may not sum to totals due to rounding.

This table measures only the number of tiers below a given entity, not the number of tiers that might 

be above it, because the focus of this table is each partnership’s and S corporation’s investment 

structure. This means that the table does not show whether the partnership or S corporation is itself 

part of the investment structure of another flow-through entity, and therefore does not necessarily 

show whether it is part of multitiered network.

Most ultimate owners of partnerships and S corporations are individuals. 

This ownership structure is the most simple. Structures with ultimate 

owners that are businesses are more complex because the businesses, 

in turn, are controlled by other entities. For example, C corporations are 

controlled by their boards and shareholders.

Most partnerships and S corporations were owned exclusively by 

individuals in tax year 2011. S corporations’ ownership was simplest, with 

97 percent of all S corporations owned exclusively by individuals. 

Partnerships showed greater complexity, with 77 percent of all 

partnerships owned exclusively by individuals and 22 percent owned by 

Most Ultimate Owners Are 

Individuals
Appendix II: Multitiered Networks of 

Partnerships and S Corporations

Page 40 GAO-14-453 Partnerships and S Corporations

mixed types of owners.3

Table 4: Types of Ultimate Owners of Partnerships and S Corporations, Tax Year 

2011

The types of owners for partnerships and S 

corporations in tax year 2011 are shown in table 4.

Type of owner Partnerships S corporations

Approximate number

Only individuals who filed tax returns 2,597,000 4,118,000 

Only businesses that filed tax returns 23,000 10,000 

Only individuals, businesses, and other entities that 

did not file tax returnsa 24,000 28,000 

Mix of the above categories 738,000 80,000 

Total 3,382,000 4,237,000 

Percent

Only individuals who filed tax returns 77% 97%

Only businesses that filed tax returns 1% 0%

Only individuals, businesses, and other entities that 

did not file tax returnsa 1% 1%

Mix of the above categories 22% 2%

Total 100% 100%

Source: GAO analysis of IRS data.

Notes:

Because the K-1 database does not have complete K-1 data, entity counts are approximate.

Columns may not sum to totals due to rounding.

a

Entities not filing tax returns include legitimate nonfilers such as business subsidiaries and 

individuals not required to file. They may also include nonfilers who should be filing and parties with 

invalid taxpayer identification numbers.

Another factor in the complexity of a flow-through entity is the number of 

ultimate owners (see the text box above for a definition of ultimate 

owners). As shown in figure 7, most S corporations are closely held, i.e., 

owned by a small number of ultimate owners. In tax year 2011, 62 

percent had only one ultimate owner, and an additional 28 percent had 

only two ultimate owners. Partnerships tend to have more ultimate 

 3

About 1 percent of both partnerships and S corporations had ultimate owners that did not 

file tax returns in tax year 2011. These may have been individuals or businesses, and they 

may have been excused from filing or may not have filed when they should have filed.

Most Partnerships and S 

Corporations Have 1 to 2 

Ultimate Owners, but 

Many Have 11 or More
Appendix II: Multitiered Networks of 

Partnerships and S Corporations

Page 41 GAO-14-453 Partnerships and S Corporations

owners. In tax year 2011, 51 percent had 2 ultimate owners, 38 percent 

had 3 to 10 ultimate owners, and 9 percent had 11 or more ultimate 

owners.

Figure 7: Number of Ultimate Owners for Partnerships and S Corporations, Tax 

Year 2011

Notes:

Because the K-1 database does not have complete K-1 data, the extent of tiering presented in this 

figure represents a minimum amount, and entity counts are approximate.

Percentages for S corporations do not sum to 100 percent due to rounding.

Most enterprises (see text box above for definition) are simple and have 

few component entities, but some are multitiered and have large numbers 

of component entities (see figure 8). Enterprises are of particular interest 

to IRS because controlling owners have the ability to influence activity 

throughout the network. In tax year 2011, about 62 percent of enterprises 

Most Enterprises Are 

Simple, but Some Are 

Multitiered with Many 

Component Entities
Appendix II: Multitiered Networks of 

Partnerships and S Corporations

Page 42 GAO-14-453 Partnerships and S Corporations

had two tiers—i.e., they were simple networks—and were composed of 

about four entities on average (counting both flow-through entities and 

ultimate owners).4

Figure 8: Number of Enterprises and Average Number of Entities per Enterprise, by Tiering Depth, Tax Year 2011

About 35 percent of enterprises had three tiers and 

were composed of about five entities on average. In comparison, the 

seven enterprises that were nine or more tiers deep were composed of 

about 735 entities on average.

Notes: Because the K-1 database does not have complete K-1 data, the extent of tiering presented in 

this figure represents a minimum amount, and entity counts are approximate.

Averages for numbers of entities include both flow-through entities and ultimate owners.

 4

As illustrated above in figure 6, networks with only two tiers do not have any flow-through 

entities passing income to other flow-through entities, so they are not considered 

multitiered networks.
Appendix III: Additional Information about 

Misreporting

Page 43 GAO-14-453 Partnerships and S Corporations

The Internal Revenue Service (IRS) estimated that individual taxpayers 

misreported, in net terms, 15 percent of the total income from 

partnerships and S corporations that they should have reported on their 

tax returns.1

Figure 9: What Net Misreporting Percentage Means

This percentage is known as the net misreporting 

percentage (see figure 9).

Note:

The numerator is the sum of all amounts underreported minus the sum of all amounts overreported 

on an item, such as income allocated from partnerships and S corporations. The denominator is the 

sum of the absolute values of the amounts that should have been reported on that item. Absolute 

values are used for the denominator to prevent negative income amounts from canceling out positive 

income amounts.

We calculated the total income that should have been reported—$606

billion—from the IRS’s National Research Program (NRP) data on 

individual taxpayer compliance as the sum of the absolute values of the 

income amounts that individual taxpayers should have reported. Absolute 

 1

Relative margins of error for all estimates are less than plus or minus 10 percent unless 

otherwise noted. However, due to non-sampling error related to the uncertainty about 

undetected misreporting, actual amounts may be outside of those margins.

Appendix III: Additional Information about 

Misreporting

Methodology for 

Estimating Individuals’

Total Misreporting of 

Income from Partnerships 

and S Corporations
Appendix III: Additional Information about 

Misreporting

Page 44 GAO-14-453 Partnerships and S Corporations

values are used in calculating the amount of income that should have 

been reported to prevent negative income amounts from canceling out 

positive income amounts. Based on these figures, we estimated that in 

tax years 2006 through 2009, individual taxpayers reported about $91

billion less per year in net income from partnerships and S corporations 

than they actually were allocated. To arrive at the $91 billion estimate, we 

adjusted upward based on IRS’s 15 percent misreporting percentage 

estimate from a raw estimate of $27 billion.2

There is some uncertainty with both IRS’s estimated net misreporting 

percentage and the amount of total income from partnerships and S 

corporations individual taxpayers should have reported. IRS arrived at an 

estimate of 15 percent for the net misreporting percentage by adjusting 

upward the net misreporting percentage based on raw data from its NRP. 

In NRP, IRS selects a random sample of individual tax returns each year 

to examine and strives to verify information taxpayers reported or should 

have reported. The net misreporting percentage based directly on NRP 

data was 4.5 percent for income allocated to individuals by partnerships 

and S corporations. According to IRS officials, this was probably an 

understatement because it did not include misreporting undetected by 

IRS examiners or possible misreporting at the flow-through entity level 

carried through to individual taxpayers. Based on an IRS study of S 

corporation (but not partnership) returns from 2003 and 2004, IRS 

officials said that the net misreporting percentage for income from both 

partnerships and S corporations for tax years 2006 through 2009 was 

probably around 15 percent. IRS used only the S corporation study to 

arrive at the 15 percent because it has not conducted a similar study of 

partnerships in recent years. We cannot know whether the estimate might 

have been higher or lower if partnerships were taken into account. Each 

of the factors mentioned here—undetected individual misreporting, entitylevel misreporting, the age of the data in the S corporation study, and the 

lack of information on partnerships—creates some uncertainty about the 

15 percent estimate.

Because of the uncertainty related to IRS’s net misreporting percentage, 

there is also uncertainty about our estimate for net misreported amount. 

 2

The raw net misreported income amount based on NRP data was $27 billion, with a 

relative margin of error of plus or minus 21.0 percent. However, due to non-sampling error 

related to the uncertainty about undetected misreporting, the actual amount may be 

outside of those margins.
Appendix III: Additional Information about 

Misreporting

Page 45 GAO-14-453 Partnerships and S Corporations

Additionally, the confidence interval around the raw NRP estimate 

translates to a larger confidence interval for the adjusted estimate. 

Likewise, in calculating net misreported income, we considered only 

partnership and S corporation income that was separately reported on 

Form 1040’s Schedule E, Supplemental Income and Loss. Some income 

from partnerships and S corporations may also be included within, and 

reported under, other line items on Form 1040, such as capital gains.

IRS has not issued its own estimate of misreporting of partnership and S 

corporation income for 2006 or later. Our estimate of lost tax revenue 

cannot be used to compute a tax gap estimate (defined by IRS as the 

amount of tax liability faced by taxpayers that is not paid on time), as IRS 

may perform additional adjustments for its tax gap estimates.

To calculate the amount of taxes that corresponded to our misreporting 

estimate, we used NRP data to calculate the income and misreporting 

that related to individuals with different effective tax rates (defined as total 

tax divided by adjusted gross income). From 2006 to 2009, taxpayers with 

effective tax rates of less than 15 percent had an aggregate annual net 

loss on income from partnerships and S corporations, while taxpayers 

with effective tax rates of 15 percent or higher had aggregate net income. 

The highest tax bracket was 35 percent. Looking at taxpayers with 

effective tax rates between 15 and 35 percent, and using the minimum 

and maximum tax rates within each effective tax rate grouping and point 

estimates for misreporting, we calculated lower and upper bounds for the 

amount of tax that would have been owed on their misreported income 

from partnerships and S corporations. With this, we arrived at an estimate 

of $5 billion to $6 billion. Adjusting our point estimate for taxes based on 

the same methodology discussed above for our misreporting estimate, we 

arrived at an estimated $19 billion in taxes owed on the misreported 

income.
Appendix III: Additional Information about 

Misreporting

Page 46 GAO-14-453 Partnerships and S Corporations

There are several ways to compare the extent and nature of misreporting 

of partnership and S corporation income with individuals’ misreporting of 

other types of income, which are shown in table 5.3

Table 5: Individual Taxpayers’ Misreporting of Income, Annual Average for Tax Years 2006-2009 

To compare net 

misreporting of income from partnerships and S corporations with other 

types of income, we needed to use unadjusted data, because IRS had 

not issued adjusted results for 2006 or later at the level of detail needed 

for the table. For example, the unadjusted net misreporting amount for 

partnership and S corporation income shown in the table is $27 billion, as 

opposed to the adjusted amount of $91 billion.

Income type

Total reported

net income

(billions of dollars)

Net misreporting 

(billions of dollars) a

Net misreporting 

adjusted for 

undetected 

misreporting 

(billions of dollars) a a

Percent of 

taxpayers 

misreporting

this income type

Amount of 

information 

reporting 

required (per 

IRS) a

BUSINESS INCOME 

c

Partnership and S 

corporation income 

$395

(+/-14%)

$27

(+/-21%)

b $91 23% b Some

Sole proprietor income 256 152 Not estimated 74 Little or none

Rental real estate and 

royalties

Omitted 27

(+/-12%)

Not estimated 62 Little or none

Estate and trust income 17

(+/-29%)

Omitted Not estimated 8 Some

Farm income -13

(+/-26%)

10

(+/-14%)

Not estimated 77 Little or none

NONBUSINESS INCOME

(largest categories based on total income)

Wages 5,545 11

(+/-29%)

Not estimated 6 Substantial

Capital gains 493

(+/-25%)

28

(+/-29%)

Not estimated 25 Some

Pensions 460 Omitted Not estimated 10 Substantial

 3

We included the business income category types that are listed on the front of Form 

1040, and the business income subcategories listed on Schedule E of Form 1040, with 

absolute values for total reported income greater than $10 billion. We also calculated total 

reported income for all nonbusiness income categories on the front of Form 1040 and 

included the six categories with absolute values of reported incomes of more than $150 

billion each in our comparisons.

Comparison of Individual 

Misreporting of Income 

from S Corporations and 

Partnerships with 

Misreporting of Other 

Income Types
Appendix III: Additional Information about 

Misreporting

Page 47 GAO-14-453 Partnerships and S Corporations

Income type

Total reported

net income

(billions of dollars)

Net misreporting 

(billions of dollars) a

Net misreporting 

adjusted for 

undetected 

misreporting 

(billions of dollars) a a

Percent of 

taxpayers 

misreporting

this income type

Amount of 

information 

reporting 

required (per 

IRS) a

Interest

c

189 3

(+/-29%)

Not estimated 22 Substantial

Dividends 176 Omitted Not estimated 21 Substantial

Taxable Social Security 158 6

(+/-18%)

Not estimated 27 Substantial

Source: GAO analysis of IRS data.

Notes:

a

Results for dollar estimates with relative margins of error greater than plus or minus 30 percent are 

omitted, and relative margins of error greater than plus or minus 10 percent are listed in parentheses. 

All other dollar estimates are within plus or minus 10 percent of the reported values. All percentage 

estimates have relative margins of error within plus or minus 10 percentage points of the reported 

values. Due to non-sampling error related to the uncertainty about undetected misreporting, actual 

amounts of net misreporting may be outside of those margins. The unadjusted net misreporting 

numbers in this table represent a minimum, according to IRS. See the discussion above the table for 

further discussion.

b

According to IRS officials, the net misreporting percentage we calculated based on National 

Research Program data (4.5 percent) is probably an understatement. Based on the results of its 

2003-4 study of S corporations, IRS officials estimated that the true net misreporting percentage for 

2006 was closer to 15 percent, and, using this percentage, we calculated the 2006-9 net misreporting 

amount to be about $91 billion. While IRS officials have not issued similar estimates, they said that 

the same reasoning they used for 2006, discussed above in this report, would also apply for 2007 

through 2009.

c

This column refers to information provided by third parties to IRS. The amount can be substantial in 

the case of W-2s for wages paid to individuals, some as for K-1s, and little or none for business 

income earned by sole proprietors.

In general, frequency of misreporting of income from partnerships and S 

corporations was lower than for income from sole proprietorships, and 

higher than for misreporting of income from nonbusiness sources. There 

is a general pattern in misreporting of income. The more third-party 

information reporting there is for a type of income (such as W-2s for 

wages), the less misreporting there is for that type of income (see table 

5). According to IRS, information reporting increases voluntary tax 

compliance because taxpayers know that IRS is aware of their income. 

For example, employer information on wages and earnings is sent both to 

employees and to IRS, and for tax years 2006 through 2009, the net 

misreporting percentage for wages was less than 1 percent.

Partnerships and S corporations send partners, shareholders, and IRS 

Schedules K-1 that state the amount of income distributed to each partner 

or shareholder. In comparison, most other types of business income 

earned by individuals are covered by little to no information reporting. 

However, according to IRS officials, many partnerships and S 
Appendix III: Additional Information about 

Misreporting

Page 48 GAO-14-453 Partnerships and S Corporations

corporations issuing K-1s are closely held, i.e., controlled by the individual 

taxpayers receiving the K-1s. In these cases, the information on the K-1 

does not truly come from an unrelated third party.
Appendix IV: Additional Information about K-1 

Matching

Page 49 GAO-14-453 Partnerships and S Corporations

Schedule K-1 reporting is complex for several reasons:

• Some taxpayers with K-1 income have K-1s from multiple 

partnerships and S corporations, which adds complexity. For 

example, a taxpayer may net the income/loss amounts from different 

K-1s, so that the netted amount reported on the 1040 will not match 

the individual K-1s, but correct information may turn out to be 

contained within the netted numbers, according to IRS officials.

• One tax return preparer we interviewed noted that when tiered 

networks are involved (e.g., partnerships that have other partnerships 

as partners), each tier must wait for the tier above it to send its K-1s in 

order to have accurate information, yet they all have the same filing 

deadline. If the top-tier entity sends its K-1s close to the deadline, the 

lower tiers must estimate the amounts to put on their own K-1s in 

order to file on time. This can lead to inaccuracies and mismatches.

• When taxpayers respond to notices about mismatches, IRS guidance 

directs AUR reviewers to consider the reasonableness of taxpayers’

responses, but reviewers generally do not examine the accuracy of 

the information in the responses because they do not have 

examination authority.

• K-1 matching is only designed to detect noncompliance at the 

taxpayer level, not at the entity level. According to an IRS official, 

because many partnerships and S corporations issuing K-1s are 

controlled by the individual taxpayers receiving the K-1s, the 

information on K-1s may match what is on the Forms 1040 but still 

understate taxes owed.

Because of issues like these, K-1 matching is only part of IRS’s efforts to 

ensure compliance with tax rules about income from partnerships and S 

corporations. Examinations, discussed previously, also play a role.

Appendix IV: Additional Information about K1 Matching

K-1 Matching Is 

Complicated for Several 

Reasons
Appendix IV: Additional Information about K-1 

Matching

Page 50 GAO-14-453 Partnerships and S Corporations

The screen-out rate (percent of returns reviewed without taxpayer 

contact) and the no-change rate (percent of taxpayers contacted that did 

not result in an assessment) for K-1 matching for tax year 2009, the latest 

year for which complete data were available, were higher than for the 

Automated Underreporter (AUR) program overall (AUR matches 1040s 

with many information documents, including K-1s). As shown in figure 10, 

about 61 percent of the returns with partnership and S corporation K-1 

mismatches in IRS’s AUR workload were screened out.1

 1

Because of resource issues, IRS selects only a portion of K-1 mismatches for inclusion in 

the workload.

That is, the AUR 

examiner determined that despite the mismatch, the taxpayer was in 

compliance with tax law or within a small tolerance threshold (i.e., income 

or expenses were misreported by an amount below what IRS considers 

productive to address), and the AUR examiner did not contact the 

taxpayer. In contrast, about 18 percent of all returns in the total AUR 

workload were screened out. Of the partnership and S corporation 

mismatch cases where IRS contacted a taxpayer, the no-change rate was 

about 58 percent. In contrast, the no-change rate for all of AUR was 

about 19 percent.

Individual Tax Returns with 

Partnership and S 

Corporation K-1 

Mismatches Had Higher 

Screen-out and NoChange Rates Than All 

Returns in IRS’s Matching 

Program
Appendix IV: Additional Information about K-1 

Matching

Page 51 GAO-14-453 Partnerships and S Corporations

Figure 10: Case Processing Results for Partnership and S Corporation Mismatches Involving Schedules K-1 and All AUR 

Mismatches, Tax Year 2009 (Percentages and Numbers of Returns)

Notes:

Schedules K-1 are information returns that partnerships and S corporations are required to send to 

each of their partners and shareholders, respectively, reporting how much income or loss they 

allocated to that partner or shareholder in the past year. They also send a copy to IRS.

Numbers may not match up precisely due to rounding.
Appendix V: Comments from the Internal 

Revenue Service

Page 52 GAO-14-453 Partnerships and S Corporations

Appendix V: Comments from the Internal 

Revenue Service
Appendix V: Comments from the Internal 

Revenue Service

Page 53 GAO-14-453 Partnerships and S Corporations
Appendix VI: GAO Contact and Staff 

Acknowledgments

Page 54 GAO-14-453 Partnerships and S Corporations

James R. White, (202) 512-9110, whitej@gao.gov

In addition to the contact named above, Jeff Arkin and David L. Lewis, 

Assistant Directors; Sara L. Daleski; Deirdre Duffy; Lois A. Hanshaw; 

Lawrence M. Korb; Veronica O. Mayhand; Donna L. Miller; John W. 

Mingus, Jr.; Meredith Trauner Moles; Mark F. Ramage; Albert C. Sim; 

Andrew J. Stephens; Sonya Vartivarian; James A. Wozny; and John M. 

Zombro made key contributions to this report.

Appendix VI: GAO Contact and Staff 

Acknowledgments

GAO Contact

Staff 

Acknowledgments

(451026)
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